At the end of next month, the UK is set to leave the EU. While everybody has known and understood the significance of March 29th 2019 since the Article 50 process was triggered two years ago, it is quite staggering the lack of progress that has subsequently been achieved.

The problem is that the EU side is quite clear about what it wants to achieve, which is to preserve the integrity of the Single European Market. The UK side is so deeply divided, that all it really understands is what it does not want, but there is absolutely no consensus about what it does want.

Having had her Withdrawal Agreement comprehensively defeated a few weeks back, the Prime Minister scored a rare victory last week in Parliament when she supported a victorious motion to have the so-called Irish backstop renegotiated with the EU. The EU appears adamant that it will not renegotiate the backstop, to which she signed up to a few short months ago and which she argued was the only option a few weeks ago. Parliament also voted to avoid a no-deal Brexit, which does not make very much sense, because in theory at least, if the EU agrees to revisit the backstop and if no alternatives can be found, then a no-deal Brexit would appear to be the only real option. However, nothing can be taken for granted in relation to the deeply divided UK parliamentary process at the moment.

It has appeared inconceivable to me since the beginning of the process that if the UK and Ireland have different trading arrangements, a hard border could possibly be avoided. The real issue is that the strip of land between the Republic of Ireland and Northern Ireland is not just the Irish border, post-UK exit, it will become the EU border. As such, it will be the only land border between the UK and the EU. Consequently, the EU side will be adamant that this border be airtight and that the integrity of the Single European Market be preserved.

Strangely, last week the UK Parliament also rejected a motion to seek an extension to the process. However, a number of senior UK politicians have suggested in subsequent days that a delay would be sought from Brussels to get the required legislation in place and so on.

The Prime Minister now believes that when she returns to Brussels over the coming days ‘she will be armed with a fresh mandate, new ideas and a renewed determination to agree a pragmatic solution that delivers the Brexit that British people voted for, while ensuring there is no hard border between Northern Ireland and the Republic of Ireland’. This statement appears to be laced with inherent contradictions, but anything is possible at this juncture.

It is really hard to say where this process is going to head over the coming weeks but the possibility of a no-deal Brexit by accident rather than by design looks somewhat more real. Hopefully, sense will prevail in the UK political system, but that trait has been in short supply for some time. There have been a number of salutary warnings in recent days from Airbus, Dyson and particularly Nissan. In relation to the latter, Nissan has warned that it may move the production of its X-Trail out of Sunderland, which incidentally is a constituency that voted for Brexit back in 2016.

A concern for Ireland is that while on the surface, the EU appears totally supportive of the backstop agreement, I get a sense that faced with a hard Brexit, powerful business interests in Germany and elsewhere who sell a lot of stuff into the UK, might not be quite as enamored with the failure of the EU to renegotiate it and risk a no-deal Brexit. The one thing Ireland has going for it, is that the border is an EU rather than just an Irish border.

The Department of Finance published some early thoughts on how Brexit might affect the Irish economy. Under a no-deal Brexit, the view is that the Irish economy could be 4.25 per cent smaller than the current projections in five years time. Employment would expand more slowly and the unemployment rate could rise by 2 percentage points, and the public finances would deteriorate. Around 50,000 jobs would be at serious risk. Agri-food and the indigenous manufacturing exporting sectors are not surprisingly deemed to be most vulnerable. The Department also figures that by 2023, the economy would be 6 per cent smaller relative to a hypothetical ‘no Brexit’ scenario. The Department will give more detail when it publishes its April economic forecasts.

These forecasts may be overly pessimistic, but only time will answer that question. In the event of a no-deal Brexit, the Irish economy will continue to function and will be forced to adjust, just as it had to when we originally joined the EU and then when we broke the link with sterling in 1979 when we joined the European Monetary System (EMS). Unfortunately, we didn’t adjust very well after the commencement of EMU and the results were not positive, ultimately resulting in the economic crash in 2007. In the event of a no-deal Brexit we will have to up our game and focus on building up the attributes that should characterize a modern dynamic economy.

On the financial markets, there is still an amazing sense of calm in relation to Brexit. Between January 10th and January 25th, sterling appreciated from 90.23 pence to the euro to 86.56 pence. This move was obviously heavily predicated on a Brexit deal, and not surprisingly, since the Parliamentary vote last week, sterling has lost some modest ground, but probably not by enough given the heightened risks. In the event of the UK crashing out of the euro on March 29th without a deal, sterling could easily and fundamentally should go all the way to parity or above. On the other hand, as market movements showed in January, a soft Brexit would be a major boost for the UK economy, and sterling and all UK financial markets would benefit enormously.

The bottom line is that nobody really has a clue where Brexit might go over the coming weeks. My gut sense has been and continues to be, albeit with waning confidence, that pragmatism will prevail and the UK will initially have the process extended, and eventually agree a deal. Hopefully the majority of MPs who oppose a no-deal Brexit will rise to the fore.

Jim Power,
Chief Economist,
Friends First

The views and opinions expressed in this article are those of the author.

October was a torrid month for equity markets, and while November saw some pause for breath, the environment for equity investors remains quite difficult, very volatile, and intensely uncertain. The main problem for equity markets at the moment it that the euphoria created by the strong synchronised recovery in the global economy in 2017 has lost momentum in 2018 and the outlook for the year appears to be a lot more uncertain than was the case this time last year.

The majority of global economic indicators have weakened in recent times. Growth in the Euro Zone economy expanded by just 0.2% during the third quarter and by just 1.7% on an annual basis. The German economy contracted by 0.2%. Forward looking indicators in the Euro Zone are also contracting. The Purchasing Managers’ Index for manufacturing declined to 51.5 in November – this had been up at 60.6 this time last year. The services sector PMI fell to 53.1 in November, which is down from a peak of 58 at the beginning of the year. The Italian economy, its politics and its budget battles with Brussels are also justifiably giving considerable cause for concern.

The US economy is still doing well, but growth there has also eased, and the markets are now seriously questioning if the Federal Reserve will have an economic background sufficiently strong to warrant the 1% increase in official rates that is pencilled in for the coming year. A number of emerging economies are also in considerable trouble, with Turkey, Argentina, Brazil, Venezuela, and Pakistan all in varying degrees of distress. On the trade front, progress between the US and China is also not engendering confidence.

All in all, these factors are combining to create extreme nervousness and volatility for equity markets. Year to date, the Dow Jones is down 1.7%, the S&P 500 is down 1.5%, the FTSE 100 is down 8.5%, the French CAC is down 5.6%, the German DAX is down 12.3%, and the Italian market is down by 9.7%. We are not yet in bear market territory, but we are certainly in a more vulnerable place than for some time.

Looking ahead to 2019, the overall outlook looks quite uncertain from an economic and market perspective. The general expectation from official forecasters such as the IMF and OECD is that the global economy will ease modestly, but there is clearly a fear that the risks could be on the downside.One piece of good news emanating from the more uncertain Euro Zone background is that fears of an increase in official interest rates by the ECB are abating. Earlier in the year, June to be precise, the ECB suggested that rates would remain on hold through to the end of the summer of 2019, and while it is way too early to test this view, it would appear that the ECB could actually not have to increase rates at all in 2019.

On the Brexit front, it is still hard to know where we stand. At the weekend the EU-27 agreed to the draft Withdrawal Agreement and both sides are adamant in the view that this agreement is the only one on the table and cannot be re-visited or revised. For the Prime Minister Theresa May, the hard work now really begins. It is likely that the vote on the deal in Parliament will happen in the week beginning December 10th, but based on the parliamentary arithmetic as we currently understand it, the chances of the deal coming through parliament unscathed look quite remote.

This week the Prime Minister, who has shown amazing strength and resilience in an extremely difficult situation, will begin a tour of the country to try to garner popular support for it. It remains to be seen how effective this will be in helping to sway the views of the opponents in parliament, but on balance, it does appear that the odds are stacked against her in the House of Commons.

Then what? is the big question. Following rejection, it is possible that she could go back to Brussels for some minor alterations, but the chances of this swaying parliament would be remote. It is possible that she could end up with a ‘no deal’ exit, which could be hard or soft; she could force a general election, which could end up involving another vote on Brexit; the 2-year Article 50 timeline could be extended to allow more time to reach a deal acceptable to the majority; or a Norwegian type deal could be done.

The problem with all of these options is that there will be strong opposition within the House of Commons for all of them. The hope is that amidst the chaos, sanity will eventually prevail and fear of total political and economic chaos, or of Prime Minister Corbyn, will force most of the Tory Party, the DUP and possibly a few Labour dissenters to support what May got agreement on at the weekend, with perhaps a few cosmetic alterations to save face.

One does get a strong feeling that the arch-Brexiteers just want to leave the EU for once and for all and enter a world of WTO trading relationship with the EU and set about negotiating trade agreements with other countries and possibly with the EU eventually. When it comes down to it, they don’t seem to care what damage it does to the UK economy, and the damage could be quite severe until the economy adjusts to the new world order.

One way or another, the coming weeks promise to be interesting, uncertain and difficult to comprehend on the basis of logic.

Sterling got a significant boost when the Prime Minister originally announced the deal a couple of weeks back, but this boost proved very temporary once it became apparent that the deal would run into extreme difficulty in the UK. Following the EU-27 agreement to the deal, sterling has been quite unaffected, because the markets correctly realise that there is still a distance to go and many hurdles to be overcome before we can call the all clear on this particular mess.

Jim Power,
Chief Economist,
Friends First

The views and opinions expressed in this article are those of the author.